Interest-bearing debt is a measure of the long-term debt a company has. Since financial planning with business owners focuses primarily on the Equity Value of the business, interest-bearing debt plays a key role in estimating business valuation and the proceed potential of a business owner.
Interest-bearing debt directly increases the Equity Value of a business, since it must be satisfied with excesses in liquid assets (estimated as net working capital) at the time of sale
Interest-bearing debt refers to loans, bonds, notes payable, or other obligations a business has that require the payment of interest over time.
Common examples include:
Bank term loans
Revolving credit lines
Equipment financing
Bonds or debentures
Shareholder loans with interest clauses
This debt is typically long-term in nature (due beyond 12 months), though short-term interest-bearing liabilities can exist.
When working with business owners as a financial advisor, it’s important to focus on the Equity Value within the business.
In the event of a sale, debt liabilities would first need to be satisfied with any excesses in liquid assets. The remaining value after satisfying these obligations represents Equity Value, the value the shareholders are owed.
Equity Value = Enterprise Value + Net Working Capital - Interest-bearing Debt
When estimating Equity Value , liquid assets are has to satisfy short-term and long-term obligations.
For a financial advisor, gaining a comprehensive view of a client's debt means understanding business obligations as well.
This is essential for:
Exit Planning: Helping business owners understand how debt affects their eventual proceeds potential
Cash Flow Planning: Working with owners to ensure the businesses obligations can be met before taking out additional cash from the business
Debt itself is not inherently bad and can be used to support growth strategically. However, owners should be aware of the trade-off between financing growth and reducing the value of their equity at exit.
